Should Your Portfolio Run on Dunkin'?

Aug. 1.11 | About: Dunkin' Brands (DNKN)

The name Dunkin' Donuts (NASDAQ:DNKN) is synonymous with coffee and breakfast sandwiches more so than doughnuts, which is genius in itself. Customers go in determined to get their morning cup of joe and a breakfast sandwich, but once inside it is almost irresistible to not get a doughnut for the road, or a box of munchkins for the office. I have to say, though, that the stock is not irresistible to me at its Friday’s closing price of $28.93.

There are a couple of reasons why I would not dunk my cruller in the stock right now. Based on 2010 earnings found in the prospectus, the trailing P/E is about 137. That coffee has a little too much sugar in it for me. Earnings will be released for the second quarter on Aug. 3. Considering that the Wall Street firms have not announced coverage of the company yet nor have earnings estimates out, it is hard to judge what investors will do once the earnings are announced and what is said on the conference call.

We know of the ambitious plans for basically global expansion, or in any area that is not New England or New York. But how will management get the company there? Investors should soon look to lock in their 50% gain since the IPO.

Since there are no analyst estimates to use in valuation, I decided to work backwards in my model to find investor’s expectation on return on capital, which at its current stock price is a CAPM of 19.6% on three different scenarios. The difference between these three scenarios is the beta used in the calculation, which also provides a different WACC in each scenario. It is by the WACC I judged if the stock was currently expensive. The betas I used, since it is too early to judge Dunkin’s beta, were 0.5 and 1.2, which are the betas of Dunkin’s main two competitors, McDonald’s (NYSE:MCD) and Starbucks (NASDAQ:SBUX). I also used a beta of 0.85, which was the average of 0.5 and 1.2.

Year

2010

2011

2012

2013

2014

2015

Net Tangible Assets

($1,369,516,000.00)

Earnings

$0.21

$0.21

$0.21

$0.21

$0.21

Dividends

$0.00

$0.00

$0.00

$0.00

$0.00

Earnings Growth

0.00%

0.00%

0.00%

0.00%

Book Value/per share

($10.56)

($10.35)

($10.14)

($9.93)

($9.72)

($9.51)

ROCE

-1.99%

-2.03%

-2.07%

-2.11%

-2.16%

CAPM (discount rate)

19.60%

19.60%

19.60%

19.60%

19.60%

Residual Earnings

$2.28

$2.24

$2.20

$2.16

$2.11

P/B Ratio

(2.74)

(2.80)

(2.85)

(2.91)

(2.98)

(3.04)

Book Value/per share (previous year)

($10.56)

CAPM

PV Residual Earnings (current year)

$1.91

WACC

29.2000%

PV Residual Earnings (current year + 1)

$3.50

Avg. Return of S&P500

10.00%

PV Residual Earnings (current year + 2)

$6.20

Market-Risk Premium

-19.20%

PV Residual Earnings (current year + 3)

$10.56

Beta

0.5

PV Residual Earnings (current year + 4)

$17.29

CAPM

19.60%

Target Price

$28.90

Year

2010

2011

2012

2013

2014

2015

Net Tangible Assets

($1,369,516,000.00)

Earnings

$0.21

$0.21

$0.21

$0.21

$0.21

Dividends

$0.00

$0.00

$0.00

$0.00

$0.00

Earnings Growth

0.00%

0.00%

0.00%

0.00%

Book Value/per share

($10.56)

($10.35)

($10.14)

($9.93)

($9.72)

($9.51)

ROCE

-1.99%

-2.03%

-2.07%

-2.11%

-2.16%

CAPM (discount rate)

19.60%

19.60%

19.60%

19.60%

19.60%

Residual Earnings

$2.28

$2.24

$2.20

$2.16

$2.11

P/B Ratio

(2.74)

(2.80)

(2.85)

(2.91)

(2.98)

(3.04)

Book Value/per share (previous year)

($10.56)

CAPM

PV Residual Earnings (current year)

$1.91

WACC

-38.0000%

PV Residual Earnings (current year + 1)

$3.50

Avg. Return of S&P500

10.00%

PV Residual Earnings (current year + 2)

$6.20

Market-Risk Premium

48.00%

PV Residual Earnings (current year + 3)

$10.56

Beta

1.2

PV Residual Earnings (current year + 4)

$17.29

CAPM

19.60%

Target Price

$28.90

Year

2010

2011

2012

2013

2014

2015

Net Tangible Assets

($1,369,516,000.00)

Earnings

$0.21

$0.21

$0.21

$0.21

$0.21

Dividends

$0.00

$0.00

$0.00

$0.00

$0.00

Earnings Growth

0.00%

0.00%

0.00%

0.00%

Book Value/per share

($10.56)

($10.35)

($10.14)

($9.93)

($9.72)

($9.51)

ROCE

-1.99%

-2.03%

-2.07%

-2.11%

-2.16%

CAPM (discount rate)

19.60%

19.60%

19.60%

19.60%

19.60%

Residual Earnings

$2.28

$2.24

$2.20

$2.16

$2.11

P/B Ratio

(2.74)

(2.80)

(2.85)

(2.91)

(2.98)

(3.04)

Book Value/per share (previous year)

($10.56)

CAPM

PV Residual Earnings (current year)

$1.91

WACC

74.0000%

PV Residual Earnings (current year + 1)

$3.50

Avg. Return of S&P500

10.00%

PV Residual Earnings (current year + 2)

$6.20

Market-Risk Premium

-64.00%

PV Residual Earnings (current year + 3)

$10.56

Beta

0.85

PV Residual Earnings (current year + 4)

$17.29

CAPM

19.60%

Target Price

$28.90

Click to enlarge

The 0.5 beta produced a WACC of 29.2% to get to Friday’s closing price. The 1.2 beta broke the model and produced a negative 38% WACC to get to Friday’s closing price. The 0.85 beta, the average of the two, produced a 74% WACC to get to Friday’s closing price. So what can we take away from this? Two things. Over the long term, based on current numbers known from last year, Dunkin’s beta should be under one and a WACC of 74% or 29.2% is too high and unrealistic. To support the growth plans, Dunkin' will probably need to issue bonds, but no way will the rate on the bonds be 29.2% or 74%. As you plug in lower WACC numbers on the 0.5 and 0.85 beta scenarios the target price, currently based on 2010 earnings, gets invariably lower than Friday’s closing price.

Do not get me wrong. I know and like brand and its products. I like the potential growth story. I like that Dunkin' Donuts could do things with the menu that McDonald’s or Starbucks cannot do. I just do not like the price right now, which is the product of IPO giddiness. I would look to buy at a better entry point on a pullback and after the Aug. 3 conference call and earnings release.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DNKN over the next 72 hours.